Europe’s Double Dip May Be Unavoidable

The second dip of Europe’s recession should be the most anticipated recession in economic history. Everybody sees the iceberg looming ahead, but leaders can’t agree which way to turn to avoid it. Maybe there is no escape: Austerity and taxes lead to less revenue, stimulus and tax cuts lead to larger deficits. We brought ourselves to this dilemma by abandoning some sound economic principles and letting politics interfere with markets.

The situation in Europe is the result of five kinds of political failure:

1. The failure of the European Union to evolve. The euro zone was a good idea as long as there was a plan for further unification. What we have now is a loose large market with no institutional support.

2. The failure of government spending. Spending for public goods and the welfare state became a tool for the politicians who wanted to buy votes (from the middle class, farmers, etc.) instead of creating a safety net and ensuring equal opportunity.

3. The failure of tax policy. Tax evasion or unreasonable tax cuts are symptoms of the same spirit of clientelism.

4. The failure of state intervention. Politicians interested only in short-term results and easy solutions created a web of moral hazard: the market, as the natural mechanism for allocating risk (punishing bad investments and rewarding good ones) was replaced by a corporatist model in which government acted like a giant insurance agency. However, since there are not enough funds to cover everyone anymore, only banks are considered worthy of saving. This is not capitalism.

5. The failure of political elites. The tragedy of Greece and the tragicomedy of the European leaders confusing their statements with reality should be a historic example of how leadership is instrumental and its failure could be catastrophic.

The structural flaws in the European edifice will lead us to the “double dip” of the recession, unless European politicians show some hidden leadership qualities at the last minute. They still have the time to adopt some politically costly structural reforms in order to bolster growth. Most importantly, they have to convince their people how deeply intertwined our financial problems are.